Securities and Exchange Commission – Corporate & Securities Law Bloghttps://www.corporatesecuritieslawblog.com
Up-to-date Information on Corporate & Securities LawWed, 22 May 2019 23:20:41 +0000en-UShourly1https://wordpress.org/?v=4.9.10New Effort to Exempt Crypto Currency from Certain SEC, Tax and Other Regulatory Burdenshttps://www.corporatesecuritieslawblog.com/2019/04/tax-digital-unit/
https://www.corporatesecuritieslawblog.com/2019/04/tax-digital-unit/#respondFri, 19 Apr 2019 21:09:19 +0000https://www.corporatesecuritieslawblog.com/?p=3003Continue Reading]]>A new bill, the Token Taxonomy Act was introduced to congress to amend the Securities Act of 1933 and the Securities Exchange Act of 1934 to exclude digital tokens from the definition of a security, to direct the Securities and Exchange Commission to enact certain regulatory changes regarding digital units secured through public key cryptography, to adjust taxation of virtual currencies held in individual retirement accounts, to create a tax exemption for exchanges of one virtual currency for another, to create a de minimis exemption from taxation for gains realized from the sale or exchange of virtual currency for other than cash, and for other purposes.

If passed this will be a huge boost for cryptocurrency.

The bill is pretty technical. Some of the highlights are as follows.

For purposes of the act, the term ‘digital token’ means a digital unit:

(A) that is created—

(i) in response to the verification or collection of proposed transactions;
(ii) pursuant to rules for the digital unit’s creation and supply that cannot be altered by any single person or persons under common control; or
(iii) as an initial allocation of digital units that will otherwise be created in accordance with clause (i) or (ii);

(B) that has a transaction history that—

(i) is recorded in a distributed, digital ledger or digital data structure in which consensus is achieved through a mathematically verifiable process; and
(ii) after consensus is reached, resists modification or tampering by any single person or group of persons under common control;

(C) that is capable of being transferred between persons without an intermediate custodian; and

(D) that is not a representation of a financial interest in a company or partnership, including an ownership interest or revenue share.

Among other things, the bill seeks to preempt state law as follows.

No law, rule, regulation, or order, or other administrative action of any State or any political subdivision thereof—

(A) requiring, or with respect to, registration or qualification of securities, or registration or qualification of securities transactions, shall directly or indirectly apply to a digital token;

(B) shall directly or indirectly prohibit, limit, or impose any conditions upon the use of—

(i) with respect to a digital token, any disclosure document concerning an offer or sale of a digital token that is prepared by or on behalf of a person developing, offering, or selling a digital token; or
(ii) any proxy statement, report to digital token-holders, or other disclosure document relating to a digital token or a person developing, offering, or selling a digital token;

(C) shall directly or indirectly prohibit, limit, or impose conditions, based on the merits of a digital token offering or a person developing, offering, or selling a digital token, upon the offer or sale of any digital token; or

(D) shall directly or indirectly require the filing of any notices or other documents, or the assessment of any fees, with respect to digital tokens or digital token transactions.

Additionally, states and political subdivisions thereof shall retain jurisdiction under the laws of such State to investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by any person, in connection with digital tokens or digital token transactions.

Another important provision of the bill treats certain exchanges as non-taxable. The bill proposes to amend the Internal Revenue Code to state that exchange of virtual currency (as defined) shall be treated as if such exchange were an exchange of real property; that Gross income shall not include gain (up to $600) from the sale or exchange of virtual currency for other than cash or cash equivalents.

It is too early to tell whether this bill has a chance of passing. If it does, it will be historic.

]]>https://www.corporatesecuritieslawblog.com/2019/04/tax-digital-unit/feed/0United States Supreme Court Holds That Knowing Dissemination of False Statements Made by Others Can Constitute Primary “Scheme Liability” In Violation of Rule 10b-5(a) and (c)https://www.corporatesecuritieslawblog.com/2019/04/false-statements-violation/
https://www.corporatesecuritieslawblog.com/2019/04/false-statements-violation/#respondMon, 01 Apr 2019 17:29:38 +0000https://www.corporatesecuritieslawblog.com/?p=2999Continue Reading]]>In Lorenzo v. Securities & Exchange Comm., No. 17-1077, 2019 WL 1369839 (U.S. Mar. 27, 2019), the Supreme Court of the United States (Breyer, J.) held that an individual who did not “make” a false or misleading statement within the meaning of Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011) (blog article here), but instead disseminated it to potential investors with intent to defraud, can be held to have employed a scheme to defraud and/or engaged in an act, practice or course of business to defraud in violation of subsections (a) and (c) of Securities and Exchange Commission (“SEC”) Rule 10b-5, 17 C.F.R. § 240.10b-5. This decision broadens the scope of primary liability under Rule 10b-5 beyond those who make false and misleading statements to include those who knowingly “disseminate” (i.e., communicate to potential investors) such false or misleading statements. Although this decision involved an SEC enforcement action, it is likely to be invoked by plaintiffs in private securities litigation to expand the scope of named defendants beyond the issuer and individuals directly responsible for making public statements on the issuer’s behalf.

The relevant facts were not in dispute. The defendant represented himself as “Vice President-Investment Banking” for a registered broker-dealer in Staten Island, New York. In 2009, he sent emails to prospective investors at the direction of his boss, who supplied the content and approved the messages. Those emails contained false and misleading information about the client’s business. Defendant allegedly knew that.

The SEC brought an enforcement action. It determined that defendant violated Rule 10b-5 (among other provisions of the federal securities laws), issued a $15,000 fine and bar order. Defendant appealed. He argued, inter alia, that he could not be held liable under Rule 10b-5(b), which prohibits (in pertinent part) “mak[ing] any untrue statement of a material fact,” because he was not the “maker” of the statements in the emails at issue within the meaning of Janus Capital. The United States Court of Appeals for the District of Columbia Circuit agreed. SeeSecurities & Exchange Comm. v. Lorenzo, 872 F.3d 578 (D.C. Cir. 2017). The Court of Appeals nevertheless held that defendant’s conduct violated Rule 10b-5(a) and (c) which prohibit (in pertinent part) “employ[ing] any device, scheme, or artifice to defraud” and “engag[ing] in any act, practice, or course of business which operates or would operate as a fraud or deceit.” The D.C. Circuit’s decision conflicted with decisions in other Circuits holding that alleged misconduct involving misstatements in violation of Rule 10b-5(b) cannot also give rise to “scheme liability” under Rule 10b-5(a) and (c). See, e.g., WPP Luxembourg Gamma Three Sarl v. Spot Runner, Inc., 655 F.3d 1039 (9th Cir. 2011).

The Supreme Court affirmed the decision of the D.C. Circuit. In its ruling, the six-justice majority (Kavanaugh, J., did not participate) relied heavily upon the plain language of the Rule and dictionary definitions of its terms. “It would seem obvious that the words in [Rule 10b-5(a) and (c)] are, as ordinarily used, sufficiently broad to include within their scope the dissemination of false or misleading information with the intent to defraud.” The Court also seemed influenced by its view of the egregiousness of the facts of the case:

[W]e see nothing borderline about this case, where the relevant conduct (as found by the [SEC]) consists of disseminating false or misleading information to prospective investors with the intent to defraud. And while one can readily imagine other actors tangentially involved in dissemination—say, a mailroom clerk—for whom liability would typically be inappropriate, the petitioner in this case sent false statements directly to investors, invited them to follow up with questions, and did so in his capacity as vice president of an investment banking company.

The dissent (Thomas, J., in which Gorsuch, J., joined) argued that the majority’s decision undermined the limitations on the scope of securities liability established in, among other cases, Janus Capital and Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U.S. 164 (1994) (no private right of action for aiding and abetting securities fraud). The majority commented that “we can assume that Janus would remain relevant (and pre­clude liability) where an individual neither makes nor disseminates false information—provided, of course, that the individual is not involved in some other form of fraud” (emphasis in original). With respect to the blurring of the distinction between primary and secondary (aiding and abetting) liability, the majority acknowledged an overlap between the two types of liability:

Those who disseminate false statements with intent to defraud are primarily liable under Rules 10b-5(a) and (c) . . . , even if they are secondarily liable under Rule 10b-5(b). [Defendant] suggests that classifying dissemination as a primary violation would inappropriately subject peripheral players in fraud (including him, naturally) to substantial liability. We suspect the investors who re­ceived [his] e-mails would not view the deception so favorably. And as Central Bank itself made clear, even a bit participant in the securities markets “may be liable as a primary violator under [Rule] 10b-5” so long as “all of the requirements for primary liability . . . are met.”

The dissent also noted that the Court’s interpretation that Rule 10b-5(a) and (c) encompasses conduct addressed more directly in Rule 10b-5(b) effectively rendered subsection (b) superfluous. Here, too, the majority seemed unconcerned, given the breadth of the plain language of the Rule and the salutary purposes of the federal securities laws.

The Court’s decision in Lorenzo expands the scope of primary liability under Rule 10b-5. Although the majority did limit the expansion in scope in this case to those who “disseminate” false statements, plaintiffs in private securities litigation likely will invoke Lorenzo as a basis to add as defendants individuals and entities alleged to have participated in the fraudulent scheme under Rule 10b-5(a) and (c) through activities besides “dissemination.” We note that although the Court did not explain the legal basis for which it would be “inappropriate” to hold a “mailroom clerk” or other “tangential” persons primarily liable for disseminating false or misleading statements made by others, that basis would appear to be the separate requirement set forth in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008) (blog article here), that investors plead and prove they (or the market generally) were aware of the deceptive conduct at issue, i.e., they knew of and relied upon the fraudulent acts of the “mailroom clerk” or other “tangential” participants. Lower courts will need to grapple with these issues left open by the Supreme Court’s decision in this case.

]]>https://www.corporatesecuritieslawblog.com/2019/04/false-statements-violation/feed/0With the SEC, Cooperation is Keyhttps://www.corporatesecuritieslawblog.com/2019/03/cooperation-gladius/
https://www.corporatesecuritieslawblog.com/2019/03/cooperation-gladius/#respondFri, 08 Mar 2019 18:29:14 +0000https://www.corporatesecuritieslawblog.com/?p=2988Continue Reading]]>As an expensive “slap on the wrist,” the Securities and Exchange Commission (“SEC” or the “Commission”) recently concluded that approximately $12.7 million worth of funds raised in a 2017 Initial Coin Offering (“ICO”) by Gladius Network LLC (“Gladius”) were part of an unregistered securities offering, and all proceeds must be returned to investors. However, the penalty to Gladius for their regulatory violations was zero.

In recent years, the SEC has brought a number of actions involving offerings of digital asset securities including ICOs. These actions have principally focused on two important questions. First, the SEC examines when is a digital asset a “security” for purposes of the federal securities laws, and if the digital asset is a “security,” the SEC examines what registration requirements apply, if any. After the Commission warned in its Decentralized Autonomous Organization (DAO) Report of Investigation that ICOs can be securities offerings, Gladius raised approximately $12.7 million in digital assets. Gladius did not register its ICO under the federal securities laws. Moreover, the ICO did not qualify for an exemption from registration requirements. However, in the summer of 2018, Gladius proactively elected to self-report to the SEC’s enforcement staff and expressed an interest in taking prompt remedial steps, then cooperated with the SEC investigation. Unlike a number of other unregistered ICO enforcement actions, the SEC imposed no penalties because Gladius self-reported its conduct, agreed to compensate investors and agreed to register the tokens as a class of securities.

In other cases where proactive measures or cooperation with regulators were absent, the SEC enforced much harsher penalties. For example, two former executives behind the AriseCoin ICO were stopped by the SEC in 2018 and ordered in federal court to pay fines of nearly $2.7 million. Moreover, the then-CEO and then-COO responsible for the AriseCoin ICO were both prohibited from serving as officers or directors of public companies or participating in any future offerings of digital securities. The harsh penalties came after an SEC investigation, wherein there was little cooperation by AriseCoin. In fact, the SEC sought emergency relief to prevent investors from being victimized by the many misrepresentations throughout the AriseCoin ICO, and halted hundreds of millions in investment.

The SEC will impose penalties, even in ICOs where fraudulent misrepresentation is absent. Last year, the SEC imposed large civil penalties solely for ICO securities offering registration violations against two companies, CarrierEQ Inc. (Airfox) and Paragon Coin Inc. Both conducted ICOs, like Gladius, after the SEC warned that ICOs can be securities offerings. Airfox, a Boston-based startup, raised approximately $15 million worth of digital assets. Paragon, an online entity, raised approximately $12 million worth of digital assets. Neither Airfox nor Paragon registered their ICOs pursuant to the federal securities laws, nor did they qualify for an exemption to the registration requirements. The SEC imposed $250,000 penalties against each company and required actions to compensate and reimburse harmed investors who purchased tokens in the illegal offerings.

Since 2017, the number of new ICOs has steadily increased through 2018. However, as one might expect with the increasing competition, the amount of capital raised by each ICO has, on average, decreased. In 2018, the average amount of funds collected by a single ICO was $11.52 million. This is a sharp decrease from the average amount of funds collected by a single ICO in 2017, which was $24.35 million. Even after a dramatical downsizing, the crypto market is still larger than at the beginning of the upward trend in 2017, and many are focusing on alternative ways to finance the crypto industry in light of the fact that the SEC has not published new rules regarding digital securities or security tokens to address gray areas in this time of uncertainty.

The trend in leading crypto market exchanges is backing Security Token Offerings (STOs). Unlike an ICO, a security token denotes an investment contract into an underlying investment asset, such as stocks, bonds, funds or real estate investment trusts. When one invests in traditional stocks, ownership information is written on a document and a digital certificate is issued. For STOs, the process remains the same, except the transaction is recorded on a blockchain and a security token is issued. STOs offer the advantage of regulatory predictability to both traditional and crypto investors because security tokens are straightforwardly classified and fit into exhibiting regulatory frameworks in place for traditional securities. With STOs, all parties have an increased likelihood of avoiding regulatory purgatory, making STOs more attractive to most investors and issuers.

The era of mega ICOs is coming to a slow halt. Companies which have successfully conducted an ICO in the past would be wise to proactively correct any regulatory missteps, including the failure to register, make proper disclosures or any other litany of violations. Careful corrections to past ICOs may be necessary to avoid potentially enormous regulatory fines, as exemplified by the relative leniency the SEC showed with respect to Gladius based on its self-reporting and cooperative actions with the SEC enforcement staff.

Item 401(e) of Regulation S-K requires “a brief discussion of the specific experience, qualifications, attributes or skills that led to the conclusion that the person should serve as a director.” Item 407(c)(2)(vi) of Regulation S-K requires disclosure of how a company’s board (or nominating committee) implements policies that it follows with regard to the consideration of diversity in identifying director nominees.

In new CDIs Questions 116.11 and 133.13, the SEC stated that, to the extent the board or nominating committee, in determining the specific experience, qualifications, attributes, or skills of an individual for board membership, considered any such self-identified diversity characteristics of a director who consented to the disclosure of those characteristics, they would expect the company to identify those characteristics and discuss how they were considered. The SEC also stated that they expect that any description of diversity policies followed by the company would include a discussion of how the company considers the self-identified diversity attributes of a nominee, as well as any other qualifications its diversity policy takes into account, such as diverse work experiences, military service, or socio-economic or demographic characteristics.

While the SEC does not define diversity, permitting companies to define it in ways they consider appropriate, all public companies should be prepared to be more transparent in their diversity discussions in their SEC filings.

]]>https://www.corporatesecuritieslawblog.com/2019/02/sec-issues-new-guidance-on-diversity-disclosure-requirements/feed/0Expansion of Regulation A to Reporting Companies: Increased Alternatives Now Available to Public Companies Seeking to Raise Capital or for Mergers and Acquisitionshttps://www.corporatesecuritieslawblog.com/2019/02/expansion-regulation-a/
https://www.corporatesecuritieslawblog.com/2019/02/expansion-regulation-a/#respondFri, 01 Feb 2019 16:49:12 +0000https://www.corporatesecuritieslawblog.com/?p=2969Continue Reading]]>On December 19, 2018, the SEC announced that it had adopted final rules that allow reporting companies to rely on the Regulation A exemption from registration for their securities offerings.[1]

Until recently, the only way that companies subject to the reporting requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) have been able to access the capital markets has been through a private placement in public equity (PIPE) or a traditional registered public offering. PIPE’s have presented a number of issues regarding confidentiality, illiquidity of securities, limitations on offering size[2] and greater pricing discounts, whereas registered public offerings can be both time-consuming and costly. These issues are particularly magnified for smaller public companies that may not be eligible to use S-3 shelf registrations.

In announcing the new rules, SEC Chairman, Jay Clayton, stated “[t]he amended [Regulation A] rules will provide reporting companies additional flexibility when raising capital.” This additional flexibility will assist reporting companies in raising capital by reducing costs and streamlining the registration process similar to the streamlined process of registering securities on a Form S-3.

Regulation A provides an exemption from the registration requirements of the Securities Act of 1933, as amended, for offerings of securities that do not exceed $50 million in a 12 month period, and was only initially available to companies that were not subject to the reporting requirements of the Exchange Act.

Reporting companies may want to consider using Regulation A for reasons including, but not limited to the following:

Tier 2 issuers that are not listed on national exchanges are eligible for blue sky preemption. This means that OTC listed issuers do not have to make blue sky filings on a state by state basis for a public offering – this is particularly significant for smaller (OTC listed) issuers that traditionally were only able register their secondary offerings in a very limited number of states;

Tier 2 issuers may solicit investors such as qualified institutional buyers, accredited investors and non-accredited investors before the SEC qualifies an offering circular which permits an issuer to gauge investor interest prior to launching the offering;

Subject to certain regulations, securities issued in a Regulation A offerings are unrestricted and freely tradeable; and

Regulation A offers cost and time savings compared to traditional offerings. In addition to amending 17 CFR 230.251, the SEC will eliminate the reporting requirements set forth in 17 CFR 230.257 so that Tier 2 issuers will be deemed to meet the periodic and current reporting requirements under Regulation A if they have otherwise complied with the reporting requirements of the Exchange Act.

Prior to the new rules, Regulation A has been used for a number of notable initial public offerings, such as Elio Motors, Inc., Myomo, Inc., Chicken Soup for the Soul Entertainment, Inc. and ShiftPixy, Inc., among others. Each of these issuers were able to utilize Regulation A to sell their securities and list on a national securities exchange, such as Nasdaq and the New York Stock Exchange; however, not all issuers that have used Regulation A as an IPO avenue (mini-IPO) have been successful after listing to national exchanges. This could be due to a number of reasons, including, but not limited to: the fact that these Regulation A offerings were conducted on a best-efforts basis (rather than on a firm commitment basis), and, as such, did not include an over-allotment option which would otherwise help in market stabilization; the valuation of these companies; the performance of these companies; and limited liquidity in the after market As a result of the performance and post-IPO trading of some companies which have used the mini-IPO route, we believe Nasdaq and the New York Stock Exchange have become reluctant to list companies that do not use the traditional IPO route.

While issuers have generally used Regulation A primarily as a way to conduct an IPO, companies should now consider the variety of ways that they may utilize and take advantage of the benefits of Regulation A such as the following:

Follow-on Offerings. After completing its IPO, an issuer may offer additional securities to the public using one of the following types of follow-on offerings

◦ Primary Offering. A primary offering is an offering in which an issuer sells its securities directly to the public.◦ Secondary Offerings. A secondary offering is an offering in which selling stockholders of the issuer sells securities rather than the issuer selling its own securities. Although issuers do not receive any proceeds from the sale of secondary offerings, the purpose of such offerings is to provide liquidity to stockholders of the issuer.

Rights Offerings. A rights offering is an offering by the issuer to existing stockholders whereby such existing stockholders purchase additional securities of the issuer in proportion to their existing holdings. By conducting a rights offering, issuers are able to raise capital with little marketing effort and can forego large underwriting fees, and current stockholders are afforded the opportunity to maintain their percentage ownership in the issuer without being diluted by new stockholders.

Mergers and Acquisitions. The Staff of the SEC has indicated in Compliance & Disclosure Interpretation 182.07 that Regulation A can be relied upon by an issuer for business combination transactions such as mergers or acquisitions. This means that issuers can register securities using an offering circular rather than Form S-4 which is a very costly and time-consuming process. For additional information on using Regulation A for mergers and acquisitions, see Regulation A May Provide Useful Alternative to Form S-4 Registration for Public Companies Doing Smaller M&A Deal.

Initial Coin Offerings. In addition to the foregoing, while there have been discussions with respect to issuers considering using Regulation A for conducting initial coin offerings as a way to reach a large audience of potential investors which may include both accredited and non-accredited investors, to date, no such offerings have been approved by the SEC.

Issuers should consult with securities counsel for additional information about the uses of Regulation A as a way for both reporting and non-reporting companies to tap into the public markets.

Please note that the amendments to Regulation A will become effective upon publication in the Federal Register, which has not occurred as of the date this article was posted.

[2] In certain circumstances, issuers listed on Nasdaq may not sell securities through a PIPE without prior stockholder approval if, as a result of such PIPE, the issuer would issue securities in excess of 20% of the issuer’s then outstanding common stock or voting power. See Nasdaq Rule 5635(d).

]]>https://www.corporatesecuritieslawblog.com/2019/02/expansion-regulation-a/feed/0The Impact of the Government Shutdown on S.E.C. Enforcementhttps://www.corporatesecuritieslawblog.com/2019/01/impact-government-shutdown-sec-enforcement/
https://www.corporatesecuritieslawblog.com/2019/01/impact-government-shutdown-sec-enforcement/#respondThu, 24 Jan 2019 20:01:44 +0000https://www.corporatesecuritieslawblog.com/?p=2955Continue Reading]]>The federal government partial shutdown, now entering its second month, has had a severe impact upon the Securities and Exchange Commission, and its Division of Enforcement in particular, with enforcement activity coming to nearly a complete halt.

Funding for the SEC lapsed in December 2018. During a lapse of appropriations, the Anti-deficiency Act (31 USC §1341, et seq.) restricts the conduct of agencies’ staff except in very limited circumstances, including “emergencies involving the safety of human life or the protection of property.” Accordingly, the SEC immediately furloughed the majority of its personnel, leaving only a skeleton staff of supervisors to attend to ongoing emergency matters. Furloughed staff are prohibited from working until an appropriation has been enacted, and cannot even respond to email or voice mail messages.

The result is that the Division of Enforcement has virtually gone dark. All pending administrative proceedings pending before either an administrative law judge or the Commission have been stayed. The Division also has halted: (1) all investigative work, including commencing investigations and conducting investigative testimony, except as necessary for the protection of property; (2) pursuing the collection of any delinquent debts or work to distribute funds to harmed investors; and, (3) nonemergency examinations and inspections and related follow-up.

A small number of (unpaid) Division of Enforcement supervisory staff remain on duty to handle emergency enforcement matters, including temporary restraining orders and/or imminent deadline concerns, or investigations of ongoing fraud or misconduct that poses a threat of imminent harm to investors. The Division of Enforcement also continues to monitor for submissions to its Tips, Complaints, and Referrals system that appear to allege conduct that may pose a risk of imminent harm. The only litigation actions that appear to be proceeding are those necessary to comply with schedules that have been set by domestic and foreign courts and/or to avoid a delay that would prejudice the Commission’s litigation position (such as the running of a statute of limitation).

While the Division in a busy month might commence or settle several dozen enforcement actions a month, only a single action has been commenced in 2019. If the shutdown drags on for an extended period of months, risks to market participants from bad actors could increase. As the old proverb goes, when the cat is away, the mice will play.

]]>https://www.corporatesecuritieslawblog.com/2019/01/impact-government-shutdown-sec-enforcement/feed/0The Effects of the SEC Shutdown on the Capital Marketshttps://www.corporatesecuritieslawblog.com/2019/01/effects-sec-shutdown-on-the-capital-markets/
https://www.corporatesecuritieslawblog.com/2019/01/effects-sec-shutdown-on-the-capital-markets/#respondFri, 18 Jan 2019 23:47:26 +0000https://www.corporatesecuritieslawblog.com/?p=2952Continue Reading]]>Although EDGAR continues to accept filings, the government shutdown has now eclipsed its 28th day and the SEC continues to operate with limited staff which is having a crippling effect on the ability of many companies to raise money in the public markets. This is particularly due to the fact that the SEC is unable to perform many of the critical functions during the lapse in appropriations, including the review of new or pending registration statements and/or the declaration of effectiveness of any registration statements.

Although Section 8(a) of the Securities Act of 1933, as amended, creates an avenue whereby a registration statement will automatically become effective 20 calendar days after the filing of the latest pre-effective amendment that does not include “delaying amendment” language, many companies seeking to raise money in the public markets, including through an initial public offering, are reluctant to use this route for the following reasons. First, any pre-effective amendment which removes the “delaying amendment” language must include all information required by the form including pricing information relating to the securities being sold as Rule 430A is not available in the absence of a delaying amendment. This means that companies must commit to pricing terms at least 20 days in advance of the offering which may be difficult due to the volatility in the markets. In the event pricing terms change, companies must file another pre-effective amendment which restarts the 20-day waiting period. Second, companies run the risk that the SEC may, among other things, issue a stop order. Finally, companies may run into issues with FINRA, Nasdaq or the NYSE as these organizations may not agree to list securities on such exchanges without the SEC confirming that they have reviewed and cleared such filing and affirmatively declared the registration statement effective. These risks, among others, associated with using Section 8(a) as a means by which a registration statement can become effective after the 20-day waiting period, seem to outweigh the benefits of pursuing this alternative despite the fact that many companies with a December 31st year end will soon be required to file audited financial statements for the year ended December 31, 2018 pursuant to Rule 3-12 of Regulation S-X which will further delay the process resulting in an increase in both cost and time related to the offering.

Although companies seeking to raise money in the public markets, including through initial public offerings or shelf registration statements, may be reluctant to rely upon Section 8(a), some companies have already chosen to remove the “delaying amendment” language. For example, some companies which appear to have cleared all comments from the SEC prior to the partial government shutdown have elected to remove the “delaying amendment” and proceed with their offerings after the 20-day waiting period. In addition, other companies conducting rights offerings, such as Trans-Lux Corporation and Roadrunner Transportation Systems, Inc., are also relying on Section 8(a) as a means of raising money. Finally, some special purpose acquisition companies (“SPACs”), including Andina Acquisition Corp. III, Gores Metropoulous, Inc., Pivotal Acquisition Corp. and Wealthbridge Acquisition Limited, are among the issuers that are using Section 8(a) as a way to procced with their offerings during this partial government shutdown since SPACs, in particular, are not sensitive to price volatility in the markets because they have no operations.

Companies and underwriters that may be considering filing a pre-effective amendment to a registration statement to take advantage of Section 8(a) of the Securities Act should discuss the effects of removing the “delaying amendment” language with securities counsel before proceeding down such path.

]]>https://www.corporatesecuritieslawblog.com/2019/01/effects-sec-shutdown-on-the-capital-markets/feed/0Regulation A May Prove Useful Alternative to Form S-4 Registration for Public Companies Doing Smaller M&A Dealshttps://www.corporatesecuritieslawblog.com/2019/01/regulation-form-s4-registration-securities-act/
https://www.corporatesecuritieslawblog.com/2019/01/regulation-form-s4-registration-securities-act/#respondTue, 15 Jan 2019 16:58:23 +0000https://www.corporatesecuritieslawblog.com/?p=2948Continue Reading]]>Last month, the U.S. Securities and Exchange Commission (“SEC”) announced it had adopted final rules to amend certain parts of Regulation A[1] promulgated under the Securities Act of 1933 (“Securities Act”).

These new rules implement changes as directed by the Economic Growth, Regulatory Relief, and Consumer Protection Act[2] signed into law on May 24, 2018 by President Donald J. Trump. There are two conceptual changes, both affecting Regulation A as it applies to reporting companies.

The first change is to remove the existing requirement that an issuer not be subject to the reporting requirements of the Securities Exchange Act of 1934 (“Exchange Act”) immediately prior to the offering.

The second change is to eliminate the periodic and current reporting requirements of Rule 257, otherwise required for an issuer completing a Tier 2 offering under Regulation A, for any issuer that is subject to the reporting requirements of the Exchange Act, if the issuer is in compliance with its obligations thereunder.

As so amended, Regulation A could prove particularly useful to reporting companies that seek to use stock consideration ($50 million or less in a Tier 2 offering) to acquire a target company with many equity holders in a transaction that would otherwise require registration on Form S-4 due to the unavailability of Rule 506 of Regulation D or another exemption from registration under the Securities Act.

The SEC Staff has confirmed in published guidance (Compliance & Disclosure Interpretation, Question 182.07) that Regulation A may be relied upon by an issuer for business combination transactions, such as a merger or acquisition.

Advantages of Regulation A over Form S-4 Registration

As with a registered offering on Form S-4, the securities to be issued in a Regulation A offering will be unrestricted and freely tradeable under the Securities Act, though issuers and recipients of the securities will need to be mindful of transfer restrictions under Rule 144 in respect of any “control securities.”

In addition, there are several advantages to relying on Regulation A for an offering of securities related to a business combination instead of registering the offering on Form S-4:

Incorporation by reference of information with respect to the issuer.

Timing and SEC Staff comments.

Relaxed exhibit requirements.

Federal preemption of state blue sky laws.

No strict liability under Section 11 of the Securities Act.

Greater flexibility to communicate with target company shareholders.

Integration safe harbor.

Potential greater flexibility with lock-up agreements.

No filing fee.

Disadvantages of Regulation A over Form S-4 Registration

Although there are a number of advantages to using Regulation A over Form S-4, there are a few disadvantages as well as some other issues to consider:

Regulation A eligibility restrictions.

$50 million limit.

Limitation on sales of securities not listed on a national securities exchange.

The expansion of Regulation A to reporting companies may significantly reduce the compliance obligations under the Securities Act in respect of securities offerings made in connection with business combination transactions, particularly for small cap companies acquiring smaller companies with diverse shareholder bases that previously would have otherwise required an expensive and time-consuming registration on Form S-4. It will be interesting to see how practice develops in this area.

[Please note: these final rules will become effective upon publication in the Federal Register, which has not occurred as of the date this article was posted.]

]]>https://www.corporatesecuritieslawblog.com/2019/01/regulation-form-s4-registration-securities-act/feed/0Recent Development in Regulatory Enforcement of Digital Securitieshttps://www.corporatesecuritieslawblog.com/2018/09/enforcement-digital-securities-tokens/
https://www.corporatesecuritieslawblog.com/2018/09/enforcement-digital-securities-tokens/#respondThu, 13 Sep 2018 18:16:12 +0000https://www.corporatesecuritieslawblog.com/?p=2928Continue Reading]]>In a flurry of activity and confluence of developments, the SEC, FINRA and a Brooklyn federal judge have commenced actions and made rulings that continue to define the regulatory framework and obligations surrounding the sale and trading of digital securities, whether they are labeled as cryptocurrencies or tokens.

SEC Cease and Desist Order

On Tuesday, September 11, 2018, the Securities and Exchange Commission entered its first Administrative Order against a hedge fund manager that invested in digital assets, or cryptocurrencies, claiming that he violated the Securities Act of 1933 and the Investment Company Act of 1940 by failing to register with the SEC, and the Investment Advisers Act of 1940, which makes it unlawful for any investment adviser to a pooled investment vehicle to make any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading, to any investor or prospective investor in the pooled investment vehicle.

Also on Tuesday, September 11, 2018, The Financial Industry Regulatory Authority filed its first disciplinary action involving cryptocurrencies against a Massachusetts broker, claiming that he fraudulently sold HempCoins without registering them with the Securities and Exchange Commission, and that he engaged in the offer and sale of unregistered securities in contravention of Section 5 of the Securities Act of 1933 and thereby in violation of FINRA Rule 2010. The FINRA complaint can be found here.

Federal District Court Ruling on Motion to Dismiss

Finally, on Tuesday, September 11, 2018, a Brooklyn federal judge ruled that an action against a defendant that is alleged to have engaged in a fraudulent offering of virtual securities related to two Initial Coin Offerings could not be dismissed on the grounds that the digital tokens were not securities, but rather that the question of whether the tokens were securities was one that a jury would have to decide. This case is one of the first to consider the applicability of federal securities laws in a criminal case involving digital securities or tokens. The Memorandum and Order on the Motion to Dismiss can be found here.

Additional SEC Cease and Desist Order

In addition to the foregoing, there was also one more noteworthy item involving another SEC Administrative Order that involved the settlement by TokenLot LLC, an ICO “superstore”, in which they were alleged to have acted as an unregistered broker-dealer. TokenLot this was a platform that was touted as a way to purchase and engage in secondary trading of digital securities. The action was based upon claims that Token Lot violated the Securities Exchange Act of 1934 due to their failure to register as a broker-dealer while their profits were made from facilitating trades and from a percentage of funds raised during their offerings. The individuals involved agreed to industry and penny stock bars as well as bars from serving or acting as an employee, director or member of an investment company or investment adviser. The Administrative Order can be found here.

]]>https://www.corporatesecuritieslawblog.com/2018/09/enforcement-digital-securities-tokens/feed/0Airdrop of Crypto Tokens Hits Regulatory Flakhttps://www.corporatesecuritieslawblog.com/2018/08/crypto-tokens-regulatory-tomahawk/
https://www.corporatesecuritieslawblog.com/2018/08/crypto-tokens-regulatory-tomahawk/#respondTue, 28 Aug 2018 18:07:09 +0000https://www.corporatesecuritieslawblog.com/?p=2919Continue Reading]]>On August 14, 2018, the U.S Securities and Exchange Commission (“SEC”) issued a cease and desist order (the “Tomahawk Order”) against Tomahawk Exploration LLC (“Tomahawk”) and David Thompson Laurance (“Laurance”) for their actions in connection with an initial coin offering of digital assets called “Tomahawkcoins” or “TOM” (the “Tomahawk ICO”). Tomahawk and Laurance’s actions were problematic for the same reasons cited by the SEC in other recent orders related to digital assets (e.g. the Munchee Order). Consistent with such orders, the SEC determined that Tomahawkcoins are securities because they constitute investment contracts under the “Howey” test. However, what makes the Tomahawk Order particularly noteworthy are the lessons to be gleaned regarding cryptocurrency “airdropping.”

What is Airdropping?

“Airdropping” is the distribution of tokens or cryptocurrencies without monetary payment from the token recipient. The practice of airdropping tokens became prevalent in late 2017 and early 2018 when ICOs began to face stricter regulatory scrutiny. Token airdrops or “free crypto” distributions have been particularly popular in conjunction with ICO marketing campaigns, such as the Bounty Program (“Bounty Program”) offered in connection with the Tomahawk ICO. As part of its Bounty Program, Tomahawk dedicated 200,000 Tomahawkcoins, and offered third-parties between 10-4,000 Tomahawkcoins for activities such as making requests to list Tomahawkcoins on token trading platforms, promoting the coins on blogs and other online forums, and creating professional images, videos or other promotional materials. Ultimately, Tomahawk airdropped more than 80,000 Tomahawkcoins to approximately 40 wallet holders as part of its Bounty Program.

Airdropping as a Section 5 Violation

Under Section 5 of the Securities Act of 1933, as amended (the “Securities Act”), any offer and sale of securities must be registered with the SEC or exempt from registration. Section 5 regulates the timeline and distribution process for issuers who offer securities for sale. In the Tomahawk Order, the SEC found that Tomahawk’s Bounty Program constituted an offer and sale of securities because “[Tomahawk] provided TOM to investors in exchange for services designed to advance Tomahawk’s economic interests and foster a trading market for its securities.” Despite not receiving payment in exchange for the airdropped Tomahawkcoins, the SEC nonetheless found that the airdrops made in connection with the Bounty Program constituted the offer and sale of securities: “a ‘gift’ of a security is a ‘sale’ within the meaning of the Securities Act when the donor receives some real benefit…Tomahawk received value in exchange for the bounty distributions, in the form of online marketing…in the creation of a public trading market for its securities.” By offering and selling Tomahawkcoins without having a registration statement filed or in effect with the SEC or qualifying for an exemption from registration, Tomahawk and Laurance were found to be in violation of Sections 5(a) and 5(c) of the Securities Act.

Potential Consequences of a Section 5 Violation

In light of the Tomahawk Order, it is important to understand the potential consequences of a Section 5 violation, which may include the following:

SEC Enforcement Action[1]: In addition to having the power to impose monetary penalties, the SEC can also bar an individual from serving as an officer or director of a public company for a period of several years. Through the Tomahawk Order, the SEC not only imposed a $30,000 penalty (a reduced amount due to Laurance’s inability to pay a civil penalty) but also barred Laurance from acting as an officer or director of a public company or from participating in any offering of a penny stock.

Rescission Rights: Under Section 12(a)(1) of the Securities Act, purchasers of securities that were sold in violation of Section 5 of the Securities Act have a right of rescission. This right of rescission is essentially a “put right” whereby the purchasers can force the seller of the securities to buy the securities back at cost plus interest.

Control Person Liability[2]: Even if a person did not directly take part in the airdrop, under Section 15 of the Securities Act, such person might still face liability. Under Section 15 of the Securities Act, each person who, by or through stock ownership, agency, or otherwise, controls any person who violates Section 5 of the Securities Act, may also be jointly and severally liable for such Section 5 violation.

Accounting Consequences: Potential payments in respect of rescission rights may be required to be booked as contingent liabilities under GAAP, which can negatively impact financial statements and the issuer’s ability to comply with financial covenants under bank documents.

Conclusion

Any company considering airdropping tokens or other digital assets should make sure to work with their securities lawyers to confirm that such actions do not run afoul of federal or state securities laws.

[1] Directors and Officers Insurance Policies do often cover these types of claims, but just because someone has car insurance does not mean they should drive recklessly.